Goal-specific Solutions Benefit Retirement Savers

Key Takeaways:
  • Annuities can offer steady income and market protection, but only if they align with your specific financial goals.
  • Choosing the right annuity starts with understanding your needs—not chasing products.
  • While not for everyone, annuities may help risk-averse investors create reliable retirement income.

 

For investors looking to minimize market risk and reach goals such as guaranteeing a stream of income during retirement, annuities can serve as a key part of an overall retirement savings plan. But it’s important to clearly define your goals since annuities are best utilized as a solution to a specific need.

What is an Annuity?

At its core, an annuity is a contract between the investor and an insurance company. The investor pays a premium – either in the form of an up-front lump sum payment or monthly payments – and the insurance company pays out a fixed or variable stream of income, depending on the investor’s goals and the specific annuity product that is purchased.

Annuities can also serve the purpose of deferring taxes, market protection, an enhanced death benefit, long-term care supplemental income or gifting. What makes annuities unique is finding the annuity that fits your specific need.

Annuities can help calm investors’ fears about market volatility since they can provide protection from financial market downturns. Additionally, annuities can put individuals at ease about the possibility of outliving their savings.

Over the years, annuities have grown in purpose and complexity to respond to varying needs and goals of investors and pre-retirees.

Types of Annuities

Annuities come in several broad categories — fixed, variable and variable indexed:

  • Fixed annuities provide a guaranteed minimum rate of interest and fixed periodic payments to the owner. Investors often turn to fixed annuities to offset market risk and receive a fixed annual yield.
  • Variable annuities allow the owner to receive larger future payments if investments held in the annuity fund do well or smaller payments if its investments do poorly. They provide less stable cash flow than a fixed annuity, but they allow the annuitant to reap the benefits of strong returns from their fund’s investments.
  • Indexed annuities are fixed annuities that provide a return based on the performance of an equity index such as the S&P 500.
  • Deferred annuities begin payments at a future date, allowing the premium payments to accumulate over time. They can be funded with a lump sum or through periodic payments. Deferred annuities are suitable for individuals who want to plan for future income needs.

Why Choose an Annuity?

Annuities may be right for your portfolio, or not. It’s important to remember that annuities are a tool to help investors reach their goals. You wouldn’t use a wrench to pound in a nail. If your goal is to nail two boards together, you would use a hammer. It’s the same with annuities. So the first order of business is to have a discussion with your investment advisor about your goals, your concerns and your risk tolerance. The goal is not to find the best annuity and sell it to you. The goal is to understand your need or problem and then see if an annuity is the right solution.

Annuities help investors address three primary goals:

  • Tax deferral. For instance, a non-qualified (not held inside an IRA) annuity can provide tax-deferred gains, much the same as an IRA or 401(k), but with less risk.
  • Protection from financial market fluctuations. A product called a buffered annuity can provide downside protection when the stock market slides. For instance, a buffered annuity that offers downside market protection, but may limit the upside growth. This can be very helpful to minimize the market swings and help calm the fears of investors.
  • Acquiring a steady stream of income. For risk-averse investors who are concerned about outliving their savings, annuities can offer consistent income for a lifetime and potential spousal income when one spouse passes.

Annuities can be difficult to understand, and investors sometimes shy away from them as a result. Often, it takes an advisor with experience and knowledge about annuities to find something that fits the client’s goals. Even if the advisor and client have worked together for several years, a simple conversation can reveal needs and opportunities that an annuity may address.

If the investor is very risk-averse but wants to make money, that’s a fit for some type of annuity. It can also be a fit if:

  • The investor needs extra income to supplement Social Security in retirement.
  • The investor wants future income to pay for long-term care, should it be needed.
  • The investor wants to provide a legacy for children and doesn’t need the money for his or her own lifestyle.

Annuities can work immediately or can be deferred to produce a stream of income later. Annuities that are designed to provide extra income through retirement take the risk of the financial markets off the table and provide that steady stream of income monthly or annually.

Keep in mind, some annuities have a minimum investment requirement, normally in the range of $10,000 to $50,000.

How an Annuity Fits into a Portfolio

Because many investors buy annuities for relatively steady, safe returns or protection against market downturns, they often give up the strong returns that equities can provide in bullish stock markets. Annuities also are long-term investments that sometimes tie up large amounts of money for many years or reduce investors’ flexibility to move their money among investments.

For these reasons, investors typically limit annuities to no more than one-third of their portfolios.

Annuities also often come with “surrender periods,” usually a three- to ten-year initial period during which an investor who cashes out will have to pay a percentage penalty for early withdrawal. For instance, a $100,000 lump sum investment in an annuity may come with a five-year surrender period. A withdrawal during the first year might come with a 10% penalty.

For this reason, investors can’t think of annuities the same way they think of equity investments. An annuity is not a one-size-fits-all solution. Annuities must fit the goals that an owner is trying to achieve to make sense as an investment.

Some investors react with surprise when their advisors suggest an annuity as an investment option. There is still a negative vibe around annuities that goes back many years to a time when they came with unusually high expenses relative to the benefits they provided to investors.

But the insurance industry has responded to marketplace and regulatory demands. Annuities today are simpler and don’t have many of the costly that your parents or grandparents may have purchased, such as income riders and death benefits. As a result, the insurance industry has been able to keep expenses down.

Questions?

Annuities offer some investors an important tool to reach their financial goals in retirement while minimizing market risk, but it’s important to find the right annuity.

If your advisor brings up the word “annuity,” don’t dismiss it right away. It may be a good fit for you, depending on the goals you have discussed.

If you would like to discuss your savings and retirement goals, contact an Adams Brown Wealth Consultant.